Divergence and Adjustment in the Euro Area

Transcription

1 MINISTÉRIO DAS FINANÇAS Divergence and Adjustment in the Euro Area Vítor Gaspar Frankfurt June 15, 2012 MINISTÉRIO DAS FINANÇAS 1

2 Outline 1. Credit Boom 2. Eliminating excessive debt 3. Challenges ahead MINISTÉRIO DAS FINANÇAS 2

3 CREDIT BOOM MINISTÉRIO DAS FINANÇAS 3

4 The process of adjusting to the euro Expected effects r Significantly lower interest rates in peripheral countries Household s expenditure boom Increase in investment Increase in relative price of non-tradables Real appreciation of exchange rates Deterioration in current account Accumulation of a substantial negative net foreign asset position Evidence from: Facts Models MINISTÉRIO DAS FINANÇAS 4

5 The process of adjusting to the euro: facts Core countries Nominal long-term interest rate, % Household sector debt, % GDP Peripheral countries Current account balance, % GDP Relative consumer prices, % GDP Source: AMECO, OECD and ECB The variables for core countries were calculated as the arithmetic means of respective variables for Belgium, Germany, France, Austria and the Netherlands. Peripheral country variables were similarly calculated using data for Ireland, Italy, Portugal and Spain. MINISTÉRIO DAS FINANÇAS 5 75

6 The process of adjusting to the euro: model simulated results With habit formation Simulated response to a fall in interest rates (100 years) Without habit formation Given improved access to financing in converging countries reflected in lower interest rates facing agents, is it possible to use an intertemporal, endowment model to explain stylized facts? All the stylized facts can be qualitatively obtained in a simple endowment model with traded and non-traded goods Source: Fagan, G. and Gaspar, V. (2007): Adjusting to the Euro, ECB Working Paper nº MINISTÉRIO DAS FINANÇAS 6

7 Two alternative stories competing The Lawson Doctrine Description The current account deficit as an equilibrium adjustment phenomenon. In a world of integrated financial markets a current account that reflects the financial balance of the private sector is no reason for concern. Credit risk monitoring is sufficient to deal with risk. There is no policy relevant macroeconomic imbalance. References Blanchard and Giavazzi (2002) Prudent view The current account deficits reflect private savings investment gaps that are, in turn, caused by distortions or frictions. Under these circumstances deficits may be too large (they reflect imbalances and cause fragility). An extreme case is associated with the possibility of a sudden stop. Blanchard and Milesi-Ferretti (2010,2011) IMF, EC, ECB MINISTÉRIO DAS FINANÇAS 7

8 ELIMINATING EXCESSIVE DEBT MINISTÉRIO DAS FINANÇAS 8

9 The crisis suddenly shifted the process into reverse Expected effects Facts? r CR Households reduce expenditure Investment decline Tightening of financing conditions Increase in interest rates Credit constraints Decrease in relative price of non-tradables Real depreciation of exchange rates Improvement in current account Reduction in the negative net foreign asset position MINISTÉRIO DAS FINANÇAS 9

10 The reverse process has already started Core countries Nominal long-term interest rate, % Household sector debt, % GDP Peripheral countries Current account balance, % GDP Relative consumer prices, % GDP Source: AMECO, OECD and ECB The variables for core countries were calculated as the arithmetic means of respective variables for Belgium, Germany, France, Austria and the Netherlands. Peripheral country variables were similarly calculated using data for Ireland, Italy, Portugal and Spain. MINISTÉRIO DAS FINANÇAS 10

11 Financial drivers, propagation and adjustment The main driver has been financial Current account imbalances and competitiveness are symptoms not causes. When the adjustment process starts: the decline in excess demand leads to real depreciation and competitiveness improve. For small countries the adjustment proceeds without noticeable impact in the world economy The experience of Latvia is an example of a successful adjustment without external devaluation: The euro peg was maintained. Adjustment strategy: strong fiscal consolidation and structural reforms. Latvia competiveness improved GDP growth rate was at 5,5% in 2011 MINISTÉRIO DAS FINANÇAS 11

12 Competitiveness has already started to rebalance Relative Unit labor costs 1999= Germany Ireland Greece France Spain Italy Portugal Source: AMECO MINISTÉRIO DAS FINANÇAS 12

13 CHALLENGES AHEAD MINISTÉRIO DAS FINANÇAS 13

14 Policy challenges 1. 1 Weakness in prudential supervision and regulation Underestimating systemic risk 2. 2 Ineffective procedures to avoid excessive government deficits 3. 3 Insufficient attention to macroeconomic imbalances 4. 4 Structural competitiveness problems and nominal and real rigidities Labor and product market rigidities constraint a real depreciation adjustment process 5. 5 Rent-seeking economy Investment was directed to non-traded goods or other sector sheltered from competition Wide mark ups in the non traded-goods sector, wage rents in sheltered sectors Non-tradable sectors cascade excessive costs through the economy, reducing other sectors competitiveness Amplify the adjustment costs when the process is in reverse MINISTÉRIO DAS FINANÇAS 14

15 Potential problems were previously identified ( ) such a process could, as a result of inaccurate expectations, real and financial frictions and weak institutions, develop beyond what is justified by fundamentals, leading to unsustainable developments which, if not counteracted, would ultimately result in a severe crisis or in prolonged under-performance. Facing uncertainties of this magnitude, it is essential to pursue the prudent course. In particular, we would stress the importance of realistic assessment of future prospects (in the context of longer-term economic planning), extra attention to micro and macro financial stability, the importance of labor and product market flexibility and, last but not least, prudent public finance management with a strong emphasis on posterity. Fagan and Gaspar (2005), Adjusting to the euro area: some issues inspired by the Portuguese experience, paper presented at the ECB Conference on What effects is EMU having on the euro area and its member countries? June. MINISTÉRIO DAS FINANÇAS 15

16 The new European architecture addresses these fragilities The reform of the EU Economic Governance Prevention Debt sustainability Crisis prevention, management and resolution (systemic organizations: governments, financial conglomerates,...) Fiscal rules and compliance Sound and prudent fiscal policy Prevention and correction of macro imbalances Sustainable Sound fiscal policy growth Open markets and competition structural reform Adapted from Larch and Pench and Frayne, SGP 3.0, presentation, Perugia, 31 March 2 April, 2011 Financial Regulation and Supervision Innovation and entrepreneurship MINISTÉRIO DAS FINANÇAS 16

17 The Way Forward At national level (peripheral countries) At European level 1. Fiscal consolidation 2. Financial stability 3. Structural transformation 1. Economic and financial governance of the euro area 2. Preserve and deepen the single financial market 3. Cut-off the link between sovereign risk and bank risk MINISTÉRIO DAS FINANÇAS 17